Your neighbor is playing stock market roulette by buying the stocks he hears about on Reddit’s “Wall Street Bets” forum. You know he may double his money – or lose half of it – in a matter of days.
But perhaps frenzied speculation isn’t your style. Is there a sounder way?
If you want to be the adult in the room, one sensible strategy is to invest in stocks with high profitability and low debt.
Such stocks have a margin of safety. If things go wrong, the ship is unlikely to sink. And the chances of things continuing to go right are high.
To be considered for inclusion in today’s column, a company had to post a return on invested capital of 16% or more in its latest four quarters, and have debt equal to 10% of corporate net worth or less.
Here are four stocks that fit the bill.
A debt-free choice is Gentex Corp. (GNTX, Financial), which makes self-dimming mirrors for cars. It has one of the strongest profitability records I’ve seen, with a return on invested capital of 20% or more for 11 straight years.
Normally you’d expect a stock with that kind of profit history to be quite expensive. Gentex is only a little expensive. The stock trades at 21 times recent earnings, and 16 times the earnings that analysts predict for the next four quarters.
The pandemic crippled auto sales for a while, but new car sales are now bouncing back strongly, a boon for Gentex since it is an original equipment manufacturer.
Logitech International SA (LOGI, Financial) is based in Switzerland, but sells computer and mobile accessories worldwide. Among its products are charging stands, mounts, cases, speakers, cameras, keyboards and mice.
The company has posted a return on invested capital of 17% or better in each of the past eight fiscal years. Last year its figure was amazing at 84%.
As of March, it counted Jim Simons (Trades, Portfolio)' Renaissance Technologies, Paul Tudor Jones (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio) among its shareholders – three celebrated investors. At 22 times earnings, the stock isn’t cheap, but I think it’s worth the price.
The company gained a lot of revenue during the pandemic, when people were stuck indoors. So far, it appears to be hanging onto that higher revenue stream now that the pandemic is ebbing.
Turtle Beach shares sell for only 11 times recent earnings, which I consider very cheap for a company that earned 73% on invested capital. The company is debt-free.
Turtle Beach says it expects the virtual reality portion of the gaming market to grow from $1.48 billion now to $4.2 billion by 2024.
Sturm Ruger posted a 73% return on invested capital in the past four quarters. (I consider anything over 15% very good.)
Its debt is only 1% of stockholders’ equity. And the stock sells for less than 13 times earnings.
Some studies have shown that “sin stocks” outperform the overall market. It will be interesting to see whether that trend holds up given investors’ increasing interest in environmental, social and governance issues.
This is the 17th column I’ve written about stocks with high profitability and low debt.
The average 12-month return for the previous 16 columns was 13.9%. That compares favorably with the Standard & Poor’s 500 Index at 10.3%.
Eleven of the 16 sets of recommendations were profitable, and 10 beat the S&P 500.
Bear in mind that my column results are hypothetical: they don’t reflect actual trades, trading costs or taxes. These results shouldn’t be confused with the performance of portfolios I manage for clients. Also, past performance doesn’t predict future results.
My picks from one year ago gained 56.4%, versus 40.7% for the index, as the stock market recovered from its pandemic swoon in spring 2020. Align Technology Inc. (ALGN, Financial) was my best gainer, up 132%.
Disclosure: I own T. Rowe Price shares personally and for most of my clients. I own Turtle Beach in a hedge fund I manage. One of my clients owns Sturm Ruger.
John Dorfman is chairman of Dorfman Value Investments LLC in Newton Upper Falls, Massachusetts, and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at [email protected].
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